So you’ve finally found your dream home. It’s everything you’ve been looking for—spacious, close to work, and within your budget. Before making an offer, you meet with a mortgage lender, who ask for your credit score. That’s when things get tricky. You’ve heard the term “credit score to buy a home” before, but you never realized just how much it impacts your ability to secure that perfect mortgage.
Your credit score, often tied to the details in your credit report, plays a major role in determining whether you can buy a house, how much you’ll pay for it, and even the interest rate you’ll get. In fact, a high credit score can mean a lower mortgage payment, whereas a low credit score can make buying a home more expensive or even difficult. But how does this all work? Let’s dive in.
What is a Credit Score and Why Does It Matter?
Before getting into the specifics home-buying, let’s quickly walk through what a credit score actually is. It is a three-digit number that reflects your creditworthiness, or how likely you are to repay borrowed money. This score is generated from the information in your credit report, which includes details like your payment history, the total amount of debt you owe, your credit utilization (how much credit you’re using compared to your total available credit), and other factors.
In the United States, credit scores generally range from 300 to 850. The higher the number, the better your credit. Here’s a quick breakdown of what different ranges mean:
300-579: Low credit score
580-669: Fair credit
670-739: Good credit
740-799: Very good credit
800-850: Excellent credit
Banks and lenders use your credit score to assess how risky it would be to lend to you. A higher credit score indicates that you’re more likely to pay back a loan on time, which makes you a less risky borrower. This is why your credit score is so important when it comes to securing home loans.
How Does Credit Score Work in the Context of Borrowing Money?
In the U.S., when you borrow money, lenders rely on your credit score to decide whether to approve you for a loan and to determine your loan’s terms. Mortgage lenders, for example, look at your credit score, along with other factors like your debt-to-income ratio (DTI), down payment, and the type of loan you’re applying for, to determine your eligibility and the terms of your mortgage.
Your credit score is primarily affected by five key factors:
Payment History (35%)
Your history of making on-time payments on credit cards, loans, and other debts. Late payments can lower your score.
Credit Utilization (30%)
The percentage of your total available credit that you’re using. A high utilization rate can negatively affect your score.
Length of Credit History (15%)
How long your credit accounts have been open. A longer credit history can help boost your score.
Types of Credit Accounts (10%)
The variety of credit accounts you have, such as credit cards, mortgage loans, and auto loans.
New Credit Accounts (10%)
How often you apply for new credit. Frequently opening new credit accounts can temporarily lower your score.
Credit bureaus, such as Equifax, Experian, and TransUnion, are the agencies responsible for collecting and reporting your credit information. They are the ones who provide the data to create your credit report and, in turn, your credit score.
How Your Credit Score Affects Home Buying
When you’re looking to buy a house, your credit score is one of the first things a mortgage lender will check. The higher your score, the more options you’ll have when it comes to mortgage loans, and you may qualify for better terms. A higher credit score can result in lower interest rates, meaning your mortgage payment will be more affordable over the life of the loan.
On the other hand, a low credit score can affect your ability to secure a loan in the first place, or it could result in higher interest rates, making your monthly payment higher. For example, a lender may approve you for a loan, but the interest rate may be significantly higher due to a low credit score, meaning you’ll pay more over time.
Let’s break it down by the type of loan:
FHA Loan: Lower Minimum Credit Score Requirements
If you’re looking for a more affordable route, an FHA loan (Federal Housing Administration loan) might be a good option. The minimum credit score needed for an FHA loan can be as low as 580 if you’re putting down a 3.5% down payment. If your credit score is lower than 580, you may still qualify, but you’ll likely need to make a larger down payment. These loans are designed to help first-time homebuyers or those with less-than-perfect credit.
Conventional Loan: Higher Credit Score for Better Terms
A conventional loan is a loan that is not insured or guaranteed by the government. For this type of loan, the minimum required credit score is typically 620 or higher. However, the higher your score, the better your chances of getting approved for a loan with a low interest rate. If your score is in the good or exceptional credit range, you’ll likely enjoy lower interest rates, saving you money in the long run. Conventional lenders are more inclined to offer favorable terms to borrowers with high credit scores, as it signals less risk to them.
VA and USDA Loans: Additional Options
If you’re eligible for VA loans (Veterans Affairs loans) or USDA loans (U.S. Department of Agriculture loans), the minimum credit score requirements might be more flexible. VA loans are available to current and former military members and often require no down payment or mortgage insurance. USDA loans are intended for buyers in rural areas and offer low interest rates with no down payment as well. Both types of loans tend to have more lenient credit score requirements.
Credit Score and Mortgage Payment
Your credit score doesn’t just determine whether you can qualify for a mortgage; it also affects how much you’ll pay each month. A higher credit score usually means lower interest rates, and therefore, a lower monthly payment on your mortgage. For example, a borrower with a good credit score of 740 might get an interest rate of 3.5%, while someone with a low credit score of 620 could be offered a rate of 5%. Over 30 years, the difference in interest rates could add up to thousands of dollars.
In addition, if your credit score is on the lower end, you may be required to purchase mortgage insurance (PMI), especially if you’re putting down less than 20%. PMI protects the lender in case you default on the loan, but it adds to your monthly payment.
The Role of Your Credit Report
Your credit report is a detailed breakdown of your credit history, including how timely you’ve made payments on your debts and how much debt you currently owe. Lenders review this report to assess your creditworthiness. Your credit report includes details about your credit card balances, the credit accounts you’ve opened, and your payment history. If your credit report shows a lot of missed payments or high credit card balances, it could hurt your chances of getting approved for a loan or securing favorable loan terms.
How to Improve Your Credit Score Before Buying a Home
If you’re planning to buy a home soon and your credit score isn’t where you want it to be, there are steps you can take to improve it. Start by paying down credit card balances and new credit accounts, which will lower your credit utilization rate. Make sure you keep up with your payment history and avoid missing any payments. If you’re trying to qualify for a conforming loan (a loan that meets the criteria set by government-sponsored enterprises like Fannie Mae and Freddie Mac), be mindful of the conforming loan limits for your area as well.
You can also request a free copy of your credit report from the credit reporting agency to check for any errors that might be negatively affecting your score. Disputing inaccuracies on your credit report can help boost your score over time.
